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Impose a Carbon Tax

Ted Gayer is the co-director of the Economic Studies program and the Joseph A. Pechman Senior Fellow at the Brookings Institution.

Updated November 14, 2010, 1:45 PM

According to the Congressional Budget Office, the federal government is on a trajectory to hit a debt-to-G.D.P. ratio of 185 percent in 2035 (far exceeding our historical peak of 109 percent), with continued growth thereafter. This alarming scenario is due to the expected growth in spending, which the C.B.O. predicts will be 35 percent of G.D.P. in 2035 -- substantially higher than the historical spending average of 21 percent of G.D.P. (since 1980). To reduce the fiscal shortfall, the primary focus should be on reducing spending growth, especially entitlement spending.

A carbon tax or a cap-and-trade program that auctions allowances could raise upwards of $100 billion annually.

But there are also many tax reforms that could help close the fiscal gap without substantially burdening the economy. For example, a policy that puts a price on carbon emissions can provide revenue for deficit reduction. A carbon tax, or a cap-and-trade program that auctions allowances (and includes a price collar -- or maximum allowance price -- to limit costs), could raise significant revenue for deficit reduction over the next few decades.

Such a policy would differ from the climate bill that passed the House in June 2009. In an attempt to garner political support, that bill gave away allowances and allowance revenue to interested parties. For example, in 2016 only 0.2 percent of the allowance value would have been allocated toward deficit reduction. While raising revenue should not be the primary goal of climate policy, any climate bill that forgoes using revenues to reduce economically harmful taxes or deficits greatly increases its overall cost.

A well-designed climate policy could raise about $60 billion to $100 billion annually, or about a half of percent of G.D.P., putting it on par with expected revenue from excise taxes. Such a plan would make a small but meaningful dent in the deficit, which is about 9 percent of G.D.P. This is good fiscal and environmental policy.